Don’t jump the gun on celebrating the end of inflation

U.S. consumers just got some great news on the inflation front. Inflation in June, as measured by the Consumer Price Index, was just two tenths of a percent: both headline, which includes everything, and core, which excludes food and energy. 

Over the last 12 months, those two inflation numbers have amounted to just 3% for headline and 4.9% for core. Those are down significantly, although still well above the Fed’s target. Is the Fed going to celebrate by calling off its rate hiking? I don’t think so. Because buried within the report, were some very obvious problems that aren’t going away. And I say “problem” mainly on the inflation front, actually, some of it is actually quite good news. And that is, labor costs are rising quickly, because wages are going up. 

Consider one example. Food consumed at home, the stuff you buy in the grocery store, so far this year, is rising at just at six tenths of 1% annual rate, virtually zero. On the other hand, the same food, if you consume it outside your house is rising at a 6.3% annual rate more than 10 times as fast. 

What’s the difference between eating at home and eating out? Well, you do the work at home, somebody else who’s getting paid is doing the work outside. And that’s one reason that prices are much higher there. That situation is probably going to become more dramatic. We’re about to have a series of strikes or job actions in the US. 

The big one, which is going to come on August 1, is going to be a strike by the Teamsters against UPS, the largest package delivery service in the country. Why? Well, it’s not that UPS is not offering higher wages. It’s really that there’s new management of the Teamsters union. That new management came to power, won the election inside the union, by promising to get tough. And indeed, all unions now have to prove their mettle. Just 5% of private sector workers are now unionized. And the reason is unions have really not earned their keep in workers’ eyes for a long time. The only way to do that is to show some success at the bargaining table. 

Well, if you look at where things are headed, a series of strikes not just to UPS, but also including the ports and Amazon drivers and others, suggests that 6% annual wage increases are likely to become the standard for several years to come. Now, granted, the settlements originally only go to union workers. But the way the market works is that eventually all workers will come to expect a 6% pay hike. 

Needless to say, there is just no way you can get to 2% inflation, when wages are going up at 6%. because wages are part of costs. Wages are also part of demand. And when people have more money to spend, they will spend it. And if they’re spending, ie. demand is more than supply, it means inflation. Inflation may also worsen because strikes like UPS and the ones that are occurring at West Coast ports are probably going to bring back those famous supply chain disruptions that we remember so unfondly from last year. Right now, there’s a strike at the port in Vancouver. 50% of rail traffic from Canada has been eliminated by the strike, because all those boxes that were going to be unloaded in Vancouver aren’t being unloaded and so can’t be shipped to the US. 

Another threat comes from oil. Part of the good news is that gasoline prices dropped 26 and a half percent over the last 12 months. That’s a lot. Regular oil, I mean, oil by the barrel, was down 32%. But in just three trading days since the report came out, the price of oil has gone up by $6. 

The Saudis and the Russians both promised to cut their production, and looks like the oil price decline has faced its last legs. Both the Energy Information Agency and OPEC are predicting very tight supply and higher prices in the second half of this year. And oil not only feeds into gasoline, but feeds into the entire cost structure of the US economy. 

Again, it all comes down to supply and demand. If wages are going up a lot, and costs are going up a lot, then guess what’s going to happen to prices, the equilibrium inflation rate is going to start rising again. 

Now, this is not all bad news. Finally, workers are better off. In the last 12 months, real wages or wages after inflation have risen 1.2%. But in the 18 months before then, since the start of January 2021, they had dropped 4.7%. 

People really couldn’t buy as much. And you probably know that. And that was one reason we’re starting to see lagged decline in inflation. But that trend is now reversing. So how about the Fed? The Fed might be tempted and a lot of people are urging it to not raise rates anymore. 

But we have to remember the Fed was dead wrong about inflation. Last time, it said would all be transitory and instead it kept accelerating. If they’re going to have any credibility, they can’t afford to let that happen again. And so they can’t signal that their rate hiking is over until they are absolutely sure inflation is dead as a doornail. 

It may be lying on the ground right now somewhat injured, but it is hardly dead as a doornail. And so the Fed is going to continue hiking. The key to monetary policy? The key to what the Fed does is credibility. And if they lose credibility, again, it’s going to be awfully hard and much much higher interest rates will be needed to get that credibility back. 

This is Larry Lindsey for straight arrow News.